Permanently Solving Fiscal Problems: A Modern Day Fable for the States

Gunyou, John, Government Finance Review

In January 1991, newly elected Governor Arne H. Carlson inherited the worst financial crisis in Minnesota's history. Now, less than three years later, that $2 billion deficit has been turned into a $623 million surplus, Minnesota's $500 million rainy-day fund has been restored, and a balanced budget is projected for the next four years.

The first part of the story is familiar to many states. The 9happy ending is not as common.

What Is the Moral of the Story?

It is first important to understand and acknowledge that the fiscal crisis faced by the states is neither temporary nor unexpected. It is chronic and self-inflicted.

Although the end of the economic expansion that states enjoyed during the last decade definitely worsened their situations, the fiscal problems of the states will remain even after the economy fully recovers unless fundamental changes are introduced into the way they do business. The seeds of trouble were planted well before the recession when states built up an expensive structure of expectations that they can no longer afford. There are three fundamental problems.

First, states succumbed to the same near-sighted focus that has infected corporate America by making short-term decisions without regard to long-term consequences. During good times, they spent all they had on the "flavor of the month." During bad times, they raised taxes. For example, in 1989, Minnesota used a one-time windfall of $200 million to fund the initial costs of a politically popular, ongoing property tax relief program, with little regard to its future ability to sustain these expensive commitments. This single irresponsible action caused at least one-third of the state's recent fiscal crisis, and it had nothing to do with the recession.

Second, all levels of government suffer under systems that foster current spending over investments for the future. They emphasize immediate solutions to current problems and insist on maintaining outdated and costly service delivery systems, all at the expense of funding for preventative intervention. For example, countless studies have documented the cost effectiveness of investments in early childhood programs. One such study demonstrated that the savings resulting from early intervention more than cover the program costs in just four or five years. Another study showed that for every public dollar spent on prenatal care, savings on medical assistance costs during the first 60 days of life ranged from $3 to $4. These are paybacks that most economic development projects would envy. But despite the proven cost effectiveness of early childhood programs, less than 10 percent of Minnesota's human services budget is devoted to children. In contrast, about three-fourths of the budget is spent on the elderly and disabled--two very powerful special interest groups.

Third, resource allocation decisions are based more on historical spending than on program results. There is usually little relationship between what a government needs, what it spends and what it gets. If the state is paying for pollution control devices to have cleaner air, then the air should be cleaner. If a city is paying for self-sufficiency training programs, then families should be more independent. If one-half of the state's budget is paid out for better educated children, then school districts and colleges should be able to clearly demonstrate what the children are learning.

What Was Done About It?

In order to permanently solve Minnesota's chronic fiscal problems, the 1994-95 biennial budget was developed according to four new principles.

First, and most important, performance budgeting was used so that funding decisions now are based on outcomes and results rather than on efforts and good intentions. In short, it no longer matters how hard one tries if it does not work. State agencies now are required to define the results they will accomplish and will be held accountable for their performance. …

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